Morningstar ETF Clone Resorts to Managed Bond Funds

We are in the process of trying to replicate the performance of the Morningstar 401K plan with ETFs. We identified two weaknesses in the ETF portfolio -- international equity and fixed income. In the last article we dealt with the international equity portion and in this article we deal with fixed income.

We reviewed performance for each of the funds that are coupled together by sub-class type.

Ticker

Name

5 year AR (%)

3 year AR (%)

1 year AR (%)

ETF Score

Mu Fund Score

JNK

SPDR Barclays Capital High Yield Bond

4.15

6.89

11.89

35%

PHIYX

PIMCO High Yield Instl

5.51

6.10

7.11

33%

PRRIX

PIMCO Real Return Instl

5.40

4.34

5.44

28%

TIP

iShares Barclays TIPS Bond

4.10

2.46

4.06

20%

AGG

iShares Barclays Aggregate Bond

5.28

5.05

3.76

27%

PTTRX

PIMCO Total Return Instl

8.07

8.64

6.61

44%

GVI

iShares Barclays Interm Govt/Credit

5.47

5.11

13%

LSBDX

Loomis Sayles Bond Instl

6.35

4.82

8.32

35%

PRWBX

STABLEVALUE

3.96

3.07

(0.21)

16%

SHY

iShares Barclays 1-3 Year Treasury

3.65

1.99

1.07

15%

BSV

Vanguard Short-Term Bond ETF

1.08

0.90

3%

VBISX

Vanguard Short-Term Bond Index Inv

4.36

2.87

0.10

17%

Click to enlarge

We can see that in the fixed income sub-classes, the high yield bonds (JNK and PHIYX) and short term treasury (SHY, PRWBX) run neck and neck. There is a fair gap in the inflation protected bonds (TIP and PRRIX) but the biggest gaps are in the short term bonds (BSV, VBISX), intermediate bonds (AGG, PTTRX) and multi-sector bonds (GVI, LSBDX).

We will look at these last three biggest culprits.

If we consider short term bonds, the problem is that the ETFs are all very new. It might be worth swappin in VCSH going forward but there just isn't enough history yet so this is a watching brief to see how they perform:

Ticker

Name

5 year AR (%)

3 year AR (%)

1 year AR (%)

Score

VBISX

Vanguard Short-Term Bond Index Inv

4.4%

2.9%

0.1%

17%

CSJ

iShares Barclays 1-3 Year Cred

3.2%

2.1%

7%

VCSH

Vanguard Short-Term Corp Bd Id

3.7%

4%

SCPB

SPDR Barclays Capital Short Term

3.0%

3%

Click to enlarge

If we now look at the multi-sector bonds:

Ticker

Name

5 year AR (%)

3 year AR (%)

1 year AR (%)

Score

LSBDX

Loomis Sayles Bond Instl

6.4%

4.8%

8.3%

34.6%

AGG

iShares Barclays Aggregate Bon

5.3%

5.3%

3.8%

27.7%

BND

Vanguard Total Bond Market ETF

2.0%

2.3%

5.3%

BIV

Vanguard Intermediate-Term Bon

2.4%

3.8%

7.5%

PCEF

PowerShares Income Composite

9.7%

9.7%

Click to enlarge

We are again plagued with short histories and AGG performs reasonably well -- however AGG is used to match PTTRX. Some of the newer ETFs may give better alternatives in future but there is nothing that closes the gap.

PTTRX has been a staple in many portfolios and has continued to do an outstanding job of delivering consistently high returns. Again, the ETF selections lack much history although there are some promising alternatives.

Ticker

Name

5 year AR (%)

3 year AR (%)

1 year AR (%)

Score

PTTRX

PIMCO Total Return Instl

8.1%

8.6%

6.6%

44%

ITR

SPDR Barclays Cap Interm Term

6.2%

6%

VCIT

Vanguard Interm-Tm Corp Bd Idx

7.7%

8%

CFT

iShares Barclays Credit Bond

5.1%

5.5%

13%

CIU

iShares Barclays Intermediate

4.8%

4.8%

12%

CORP

PIMCO Investment Grade Corp Bd

0%

Click to enlarge

Given this background, we decided to insert the retail version of PTTRX and LSBDX -- PTTDX and LSBRX and deal with the additional fees and redemption periods. We can go back and further optimize the other fixed income but this was a big enough change that we thought we would see how it turned out.

We can see that the addition of the managed bond funds does give us a point or two of additional returns. It is important to note that this is slightly higher during the downturn when fixed income becomes even more of a focus.

If we now compare this with the original Morningstar portfolio, we can see that we have closed the gap to a large degree. Remember that the ETFs are newer and so the simulation can only put the money into cash when the ETFs don't exist.

We notice that the original portfolio has performed better with TAA in the short term but over the longer time horizons, the performances are much closer.

There is a danger that this is considered returns chasing -- that we are building a portfolio based on history and not forward looking and there is some justification to that charge. In particular, more attention could be given to some of the newer fixed income ETFs as they build history. A reasonable middle ground seems to be to either add the new funds and allow styles rotation to bring them in when merited or to wait another year and see what the historical trail looks like.

Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.